Washington, D.C. 20549

 

Form 10-Q

 

ý		QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended March 31, 2006
		OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                    to                    

 

Commission file number 0-14719

 

SKYWEST, INC.

 

 

444 South River Road
St. George, Utah 84790
(435) 634-3000

 

Indicate by a check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes     ý     No     o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer ý         Accelerated filer o         Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes     o     No     ý

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

 

Class		Outstanding at May 8, 2006
Common stock, no par value		63,681,415

 

 

SKYWEST, INC.

 

QUARTERLY REPORT ON FORM 10-Q

 

TABLE OF CONTENTS

 

		Forward-Looking Statements
PART I		Financial Information:
Item 1		Financial Statements Consolidated Balance Sheets as of March 31, 2006 (unaudited) and December 31, 2005
		Consolidated Statements of Income for the Quarters ended March 31, 2006 (unaudited) and 2005
		Condensed Consolidated Statements of Cash Flows for the Quarters ended March 31, 2006 (unaudited) and 2005
		Notes to Condensed Consolidated Financial Statements
Item 2		Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3		Quantitative and Qualitative Disclosures About Market Risk
Item 4		Controls and Procedures
PART II		Other Information:
Item 1		Legal Proceedings
Item 1A		Risk Factors
Item 6		Exhibits
		Signature
Exhibit 31.1		Certification of Chief Executive Officer
Exhibit 31.2		Certification of Chief Financial Officer
Exhibit 32.1		Certification of Chief Executive Officer
Exhibit 32.2		Certification of Chief Financial Officer

 

2

 

PART I. FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

SKYWEST, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)

 

ASSETS

 

		March 31, 2006			December 31, 2005
		(unaudited )
CURRENT ASSETS:
Cash and cash equivalents		$	147,407		$	140,614
Marketable securities		175,805			159,054
Restricted cash		22,100			24,823
Income tax receivable		1,395			12,534
Receivables, net		33,157			28,267
Inventories		72,226			68,611
Prepaid aircraft rents		223,216			178,762
Deferred tax assets		65,528			41,012
Other current assets		34,561			39,955
Total current assets		775,395			693,632
PROPERTY AND EQUIPMENT:
Aircraft and rotable spares		2,762,711			2,727,595
Deposits on aircraft		36,570			90,235
Buildings and ground equipment		154,165			150,426
		2,953,446			2,968,256
Less-accumulated depreciation and amortization		(436,352		)	(415,734		)
Total property and equipment, net		2,517,094			2,552,522
OTHER ASSETS
Intangible assets, net		32,436			33,043
Other assets		53,334			41,449
Total other assets		85,770			74,492
Total assets		$	3,378,259		$	3,320,646

 

See accompanying notes to consolidated financial statements.

 

3

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

		March 31, 2006			December 31, 2005
		(unaudited )
CURRENT LIABILITIES:
Current maturities of long-term debt		$	279,063		$	331,145
Accounts payable		82,648			95,283
Lines of credit		90,000			60,000
Accrued salaries, wages and benefits		53,676			53,105
Accrued aircraft rents		22,409			26,279
Taxes other than income taxes		19,258			18,224
Other current liabilities		35,952			31,881
Total current liabilities		583,006			615,917
OTHER LONG-TERM LIABILITIES		34,565			33,829
LONG-TERM LINE OF CREDIT		—			30,000
LONG-TERM DEBT, net of current maturities		1,461,218			1,422,758
DEFERRED INCOME TAXES PAYABLE		260,169			225,068
DEFERRED AIRCRAFT CREDITS		78,063			79,876
STOCKHOLDERS’ EQUITY:
Preferred stock, 5,000,000 shares authorized; none issued		—			—
Common stock, no par value, 120,000,000 shares authorized; 66,390,354 and 65,509,631 shares issued, respectively		380,034			364,535
Retained earnings		615,392			582,620
Treasury stock, at cost, 6,794,056 shares		(32,551		)	(32,551		)
Accumulated other comprehensive loss		(1,637		)	(1,406		)
Total Stockholders’ Equity		961,238			913,198
Total liabilities and stockholders’ equity		$	3,378,259		$	3,320,646

 

See accompanying notes to consolidated financial statements.

 

4

 

SKYWEST, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In thousands, except per share amounts)

 

		Quarter Ended March 31,
		2006			2005
OPERATING REVENUES:
Passenger		$	734,426		$	335,557
Ground handling and other		8,429			4,735
Total operating revenues		742,855			340,292
OPERATING EXPENSES:
Flying operations		398,466			178,017
Customer service		99,676			55,778
Maintenance		78,311			32,032
Depreciation and amortization		45,489			21,032
General and administrative		38,050			18,987
Total operating expenses		659,992			305,846
OPERATING INCOME		82,863			34,446
OTHER INCOME (EXPENSE):
Interest income		2,907			2,962
Interest expense		(28,543		)	(6,646		)
Other		(1,097		)	—
Total other expense		(26,733		)	(3,684		)
INCOME BEFORE INCOME TAXES		56,130			30,762
PROVISION FOR INCOME TAXES		21,542			11,997
NET INCOME		$	34,588		$	18,765
Basic earnings per share		$	0.59		$	0.33
Diluted earnings per share		$	0.57		$	0.32
Weighted average common shares:
Basic		59,118			57,668
Diluted		60,417			58,197
Dividends declared per share		$	0.03		$	0.03

 

See accompanying notes to consolidated financial statements.

 

5

 

SKYWEST, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

(In thousands)

 

		Quarter Ended March 31,
		2006			2005
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES		$	44,823		$	(12,929	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities		(33,768		)	(69,584		)
Sales of marketable securities		16,786			70,060
Acquisition Disposition of property and equipment:
Aircraft and rotable spare parts		(17,076		)	(149,226		)
Deposits on aircraft		(416		)	(10,767		)
Buildings and ground equipment		(3,739		)	(1,767		)
Proceeds from sales of aircraft		5,776			11,734
Increase in other assets		(11,623		)	(2,305		)
NET CASH USED IN INVESTING ACTIVITIES		(44,060		)	(151,855		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt		7,093			140,980
Tax benefit from exercise of common stock options		382			—
Return of deposits on aircraft and rotable spare parts		7,572			17,810
Principal payments on long-term debt		(20,715		)	(5,489		)
Net proceeds from issuance of common stock		13,488			3
Payment of cash dividends		(1,790		)	(1,756		)
NET CASH PROVIDED BY FINANCING ACTIVITIES		6,030			151,548
Increase (Decrease) in cash and cash equivalents		6,793			(13,236		)
Cash and cash equivalents at beginning of period		140,614			113,020
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	147,407		$	99,784
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest, net of capitalized amounts		$	25,895		$	4,474
Income taxes		$	100		$	69
NON-CASH INVESTING AND FINANCING ACTIVITIES
Deposits applied to delivered aircraft		$	—		$	22,043
Debt transferred to operating lease		$	—		$	55,375

 

See accompanying notes to consolidated financial statements.

 

6

 

SKYWEST, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 

Note A — Condensed Consolidated Financial Statements

 

The condensed consolidated financial statements of SkyWest, Inc. (“SkyWest, “we” or “us”) and its wholly-owned subsidiaries, SkyWest Airlines, Inc. (“SkyWest Airlines”) and Atlantic Southeast Airlines, Inc. (“ASA”) included herein have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although we believe that the following disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements reflect all adjustments that, in the opinion of management, are necessary to present fairly the results of operations for the interim periods presented. All adjustments are of a normal recurring nature, unless otherwise disclosed. We suggest that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2005 and the Company’s Current Report on Form 8-K dated September 7, 2005.  The results of operations for the three months ended March 31, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006.

 

Note B – Acquisition of ASA

 

On September 7, 2005, we completed our acquisition of all of the issued and outstanding capital stock of ASA.  ASA is a regional airline with primary hub operations in Atlanta, Salt Lake City and Cincinnati.

 

Pursuant to the terms of the Stock Purchase Agreement entered into between us, Delta Air Lines, Inc. (“Delta”), and ASA Holdings, Inc. (“ASA Holdings”) we paid $421.3 million in cash for ASA, plus $5.3 million of transaction fees.  Additionally, as part of the purchase, we assumed approximately $1,251.3 million in long-term debt which combined with the amounts paid at closing, resulted in an aggregate purchase price of approximately $1,677.9 million. The purchase price of ASA has been adjusted to reflect certain post-closing adjustments related to ASA’s working capital as of September 7, 2005.

 

In connection with the acquisition of ASA, SkyWest Airlines and Delta entered into an Amended and Restated Delta Connection Agreement and ASA and Delta entered into a Second Amended and Restated Delta Connection Agreement (collectively, the ”Delta Connection Agreements”), whereby SkyWest Airlines and ASA agreed to provide regional airline service in the Delta flight system. Among other provisions, the Delta Connection Agreements provide for the transfer of certain ownership and lease rights among SkyWest Airlines, ASA, Delta and Comair Inc., a wholly-owned subsidiary of Delta (“Comair”).  As part of the Delta Connection Agreement, SkyWest Airlines, ASA, Delta and/or Comair, as applicable, have terminated two master sublease agreements with respect to ten Canadair CRJ200 Regional Jets (“CRJ200s”) and transferred to Delta ten CRJ200s financed in part by an affiliate of Bombardier, and ASA and Delta entered into a sublease agreement whereby ASA will sublease the ten CRJ200s from Delta.

 

Under the terms of the Stock Purchase Agreement, Delta and ASA Holdings have agreed to indemnify us, and we have agreed to indemnify Delta and ASA Holdings from damages suffered due to breaches of representations, warranties or covenants made in the Stock Purchase Agreement.  Recoveries under the indemnification provisions of the Purchase Agreement are subject to certain minimum losses per event, and an aggregate minimum for all losses.  Recoveries are also subject to an aggregate cap on all losses.

 

The acquisition value of ASA was accounted for using the purchase method of accounting.  Accordingly, the aggregate purchase price was assigned to the assets acquired and liabilities assumed based on fair market values at the respective purchase date.  We recorded an intangible of approximately $33 million relating to the acquisition of ASA.  The intangible is being amortized over fifteen years under the straight-line method.

 

Note C — Stock Options

 

In August 2000, our shareholders approved the adoption of two new stock option plans: the Executive Stock Incentive Plan (the “Executive Plan”) and the 2001 Allshare Stock Option Plan (the “Allshare Plan”). Both plans became effective January 1, 2001. These plans replaced our Combined Incentive and Non-Statutory Stock Option Plans (the “Prior Plans”); however, all outstanding options under Prior Plans remain outstanding. No further grants will be made under the Prior Plans. As of March 31, 2006, there were approximately 940,000 employee options outstanding under the Prior Plans. The Executive Plan provides for the issuance of options to purchase up to 4,000,000 shares of common stock to officers, directors and other management employees of which 3,696,477 options had been issued as of March 31, 2006. The Allshare Plan provides for the issuance of options to purchase up to 4,000,000 shares of common stock to employees of the Company, of which 2,508,961 options had been issued as of March 31, 2006. The Executive Plan and Allshare Plan are both administered by the Compensation Committee of our Board of Directors (the “Compensation Committee”) who designate option grants as either incentive or non-statutory. Incentive stock options are granted at not less than 100% of the market value of the underlying common stock on the date of grant. Non-statutory stock options are granted at a price as determined by the Compensation Committee.

 

Prior to January 1, 2006, we applied Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its stock-based compensation plans.  Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, requires pro forma information regarding net income and net income per share as if we had accounted for its stock options under the fair value method.  We did not record any stock-based compensation expense related to stock options for the year ended December 31, 2005.

 

7

 

The following table contains the pro forma disclosures and the related impact on net income and net income per share (in thousands, except per share information):

 

 

Effective January 1, 2006 we adopted the fair value recognition provisions of SFAS. 123(R), Share-Based Payment, using the modified-prospective-transition method.  Under the modified-prospective-transition method, compensation cost recognized during the three months ended March 31, 2006 includes compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123(R).  Results for prior periods have not been restated.

 

The fair value of stock options has been estimated as of the grant date using the Black-Scholes option pricing model.  During the quarter ended March 31, 2006 we did not grant any stock options.  The following assumptions were used for grants for the years  ended December 31, 2005 and 2004: a risk-free interest rate of 3.87% for 2005 and 2.75% for 2004, a volatility factor of the expected common stock price of .391 for 2005 and .422 for 2004, a weighted average expected life of six years for the stock options granted in February 2005 and a weighted average expected life of four years for all previously granted options presented and an expected annual dividend rate of 0.70% for 2005 and 0.63% for 2004. We used historical data to estimate pre-vesting option forfeitures.  Forfeiture rates for the years 2005 and 2004 were 6.70% and 6.60%, respectively.  As required by SFAS 123(R), we recorded share-based compensation expense only for those options that are expected to vest.  The estimated fair value of the stock options is amortized over the vesting period of the respective stock option grants.

 

As a result of adopting SFAS No. 123(R) on January 1, 2006, our income before income taxes and net income for the quarter ended March 31, 2006 was $1.6 million and $1.3 million lower, respectively, than if we had continued to account for share-based compensation under Opinion 25.  Basic and diluted earnings per share for the quarter ended March 31, 2006 would have been $0.61    and $0.59, respectively, if the Company had not adopted SFAS No. 123(R), compared to reported basic and diluted earnings per share of $0.59 and $0.57, respectively.

 

The following table illustrates the impact of our adoption of SFAS No. 123(R) on selected operations line items for the three months ended March 31, 2006.

 

		As Reported Under SFAS No. 123 R			Under APB 25			Difference
Income before income tax		$	56,130		$	57,759		$	(1,629	)
Provision for income tax		21,542			21,900			358
Net Income		$	34,588		$	35,859		$	(1,271	)
Shares
Basic		59,118			59,118			59,118
Diluted		60,417			60,417			60,417
EPS
Basic		$	0.59		$	0.61		$	(0.02	)
Diluted		$	0.57		$	0.59		$	(0.02	)

 

Prior to the adoption of SFAS No. 123(R), we presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the Statement of Cash Flows.  SFAS No. 123(R) requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows.  The $382,000 excess tax benefit classified as a financing cash inflow would have been classified as an operating cash inflow if the company had not adopted SFAS No. 123(R).

 

8

 

A summary of stock option activity under all option plans during the three months ended March 31, 2006 is as follows:

 

Options		Shares		Weighted Average Exercise			Average Remaining Contractual Term (Years)		Aggregate Intrinsic Value
(Aggregate intrinsic value in thousands)
Outstanding at December 31, 2005		6,301,002		$	18.38
Granted		—
Exercised		(880,723	)
Cancelled		(16,408	)
Outstanding at March 31, 2006		5,403,871		$	18.87		7.0		$	48,605,291
Exercisable at March 31, 2006		2,550,650		$	19.97		5.3		$	23,729,685

 

The aggregate intrinsic value of options outstanding at March 31, 2006 is calculated as the difference between the exercise price of the underlying options and the closing market price as of March 31, 2006.

 

We had $9.4 million of total unrecognized compensation costs related to non-vested stock options.  Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.  We expect to recognize this cost over a weighted average period of 1.7 years.

 

We received $13.5 million in cash from option exercises during the three months ended March 31, 2006.

 

Note D — Marketable Securities

 

Our investments in marketable debt securities are deemed by management to be available for sale and are reported at fair market value with the net unrealized appreciation or depreciation reported as a component of accumulated other comprehensive loss in stockholders’ equity. At the time of sale, any realized appreciation or depreciation, calculated by the specific identification method, is recognized in interest income in operating results.  Our position in marketable debt securities as of March 31, 2006 and December 31, 2005 was as follows (in thousands):

 

		March 31, 2006
		(Unaudited)						December 31, 2005
Investment Types		Cost			Market Value			Cost			Market Value
Bonds and bond funds		173,458			170,812			155,192			152,929
Asset backed securities		5,068			4,993			6,167			6,125
		178,526			175,805			161,359			159,054
Unrealized
depreciation		(2,721		)	—			(2,305		)	—
Total		$	175,805		$	175,805		$	159,054		$	159,054

 

9

 

Marketable securities had the following maturities as of March 31, 2006 (in thousands):

 

 

We classified all marketable securities as short-term since we have the intent to maintain a liquid portfolio and the right to redeem the securities within the next year.

 

Note E — Passenger and Ground Handling Revenue

 

We recognize passenger and ground handling revenues when the service is provided.  Under our contract and pro-rate flying agreements with Delta and United revenue is considered earned when the flight is completed.  In the event that our contractual rates have not been finalized at quarterly or annual financial statement dates, we record revenues based on a prior period’s approved rates, adjusted to reflect management’s current estimate of the results of the then-current contract negotiations.

 

On September 7, 2005, we completed our acquisition of all of the issued and outstanding capital stock of ASA from ASA Holdings, Inc. a subsidiary of Delta.  ASA is a regional airline with primary hub operations in Atlanta, Salt Lake City and Cincinnati.  In connection with the acquisition of ASA, SkyWest Airlines and ASA entered into Delta Connection Agreements with Delta, which became effective September 8, 2005.  On September 14, 2005, Delta filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code.  With the approval of the U.S. Bankruptcy Court charged with administration of Delta’s reorganization proceedings, Delta assumed the Delta Connection Agreements on October 6, 2005.

 

Each of the Delta Connection Agreements provides for a fifteen-year term, subject to early termination by Delta or SkyWest Airlines or ASA, as applicable, upon the occurrence of certain events.  Delta’s termination rights include (i) cross-termination rights between the two Delta Connection Agreements, (ii) the right to terminate each of the Delta Connection Agreements upon the occurrence of certain force major events, including certain labor-related events, that prevent SkyWest Airlines or ASA from performance for certain periods, and (iii) the right to terminate each of the ASA Delta Connection Agreements if SkyWest Airlines or ASA fails to maintain competitive base rate costs, subject to certain adjustment rights.  In addition to the termination rights, Delta has the right to extend the term of the Delta Connection Agreements upon the occurrence of certain events or at the expiration of the initial term.  SkyWest Airlines and ASA have the right to terminate their respective Delta Connection Agreements upon the occurrence of certain breaches by Delta, including the failure to cure payment defaults.  SkyWest Airlines and ASA also have cross-termination rights between the two Delta Connection Agreements.

 

Under the terms of the SkyWest Airlines Delta Connection Agreement, Delta agrees to compensate us for our direct costs associated with operating the Delta Connection flights, plus a payment based on block hours flown.  However, among other changes, the SkyWest Airlines Delta Connection Agreement established a multi-year rate reset provision.  Under the terms of the ASA Delta Connection Agreement, Delta agrees to compensate ASA for its direct costs associated with operating the Delta Connection flights, plus, if ASA completes a certain minimum percentage of its Delta Connection flights, an additional percentage of such costs.  Additionally, ASA’s Delta Connection Agreement provides for the payment of incentive compensation upon satisfaction of certain performance goals.  Under the ASA Delta Connection Agreement, excess margins over certain percentages must be returned or shared with Delta, depending on various conditions.  The parties to the Delta Connection Agreements make customary representations, warranties and covenants, and the agreements contain other provisions typical of agreements of this kind, including with respect to various operational, marketing and administrative matters.

 

The SkyWest Airlines and ASA Delta Connection Agreements also provide a weekly payment for an amount per aircraft designed to reimburse us for certain aircraft ownership costs. In accordance with Emerging Issues Task Force No. 01-08, Determining Whether an Arrangement Contains a Lease, the we have concluded that a component of its revenue under the Delta Connection Agreements is rental income, inasmuch as the Delta Connection Agreements identify the “right of use” of a specific type and number of aircraft over a stated period of time. The amounts deemed to be rental income under the Delta Connection Agreement for the quarters ended March 31, 2006 and 2005 were $67.6 million and $18.8 million, respectively.  These amounts were recorded in passenger revenue on our consolidated statements of income.

 

Effective July 31, 2003, SkyWest Airlines entered into the United Express Agreement, which sets forth the principal terms and

 

10

 

conditions governing our United Express operations.  The United Express Agreement has received all necessary approvals from the U.S. Bankruptcy Court.  Under the terms of the United Express Agreement, SkyWest Airlines is compensated primarily on a fee-per-completed-block hour and departure basis and is reimbursed for fuel and other costs.  Additionally, SkyWest Airlines is eligible for incentive compensation upon the achievement of certain performance criteria.

 

The United Express Agreement also provides a monthly reimbursement for an amount per aircraft designed to reimburse us for certain aircraft ownership costs. In accordance with EITF 01-08, the we have concluded that a component of its revenue under the United Express Agreement is rental income, inasmuch as the United Express Agreement identifies the “right of use” of a specific type and number of aircraft over a stated period of time. The amounts deemed to be rental income under the United Express Agreement for the quarters ended March 31, 2006 and 2005 were $49.7 and $37.4 million, respectively.  These amounts were recorded in passenger revenue on our consolidated statements of income.  The United Express Agreement contains certain provisions pursuant to which the parties could terminate the agreement, subject to certain rights of the other party, if certain performance criteria are not maintained.

 

Our revenues could be impacted by a number of factors, including changes to its code-share agreements with Delta and United, contract modifications resulting from contract re-negotiations and our ability to earn incentive payments contemplated under its code-share agreements.

 

The preparation of financial statements in conformity with accounting principals generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Note F — Net Income Per Common Share

 

Basic net income per common share (“Basic EPS”) excludes dilution and is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per common share (“Diluted EPS”) reflects the potential dilution that could occur if stock options or other contracts to issue common stock were exercised or converted into common stock. The computation of Diluted EPS does not assume exercise or conversion of securities that would have an antidilutive effect on net income per common share. During the quarter ended March 31, 2006 all options were included in the computation of Diluted EPS.  During the quarter ended March 31, 2005, options to acquire 3,779,000 shares were excluded from the computation of Diluted EPS as their impact was anti-dilutive.

 

The calculation of the weighted average number of common shares outstanding for Basic EPS and Diluted EPS for the periods indicated (in thousands, except per share data) is as follows:

 

		(Unaudited)
		For the quarters ended March 31,
		2006			2005
Numerator
Net Income		$	34,588		$	18,765
Denominator
Weighted average number of common shares outstanding		59,118			57,668
Effect of outstanding stock options		1,299			529
Weighted average number of shares for Diluted net income per common share		60,417			58,197
Basic earnings per share		$	0.59		$	0.33
Diluted earnings per share		$	0.57		$	0.32

 

11

 

Note G – Comprehensive Income

 

We report comprehensive income in accordance with SFAS No. 130, Reporting Comprehensive Income, which establishes standards for reporting and displaying comprehensive income and its components in financial statements. Comprehensive income includes charges and credits to stockholders’ equity that are not the result of transactions with shareholders.  Also, our comprehensive income consisted of net income plus changes in unrealized depreciation on marketable securities, net of tax, for the periods indicted (in thousands):

 

		(Unaudited)
		For the quarters ended March 31,
		2006			2005
Net Income		$	34,588		$	18,765
Unrealized depreciation on marketable securities, net of tax		(231		)	(811		)
Comprehensive income		$	34,357		$	17,954

 

Note H – Long-term Debt and Lines of Credit

 

Long-term debt consisted of the following for the periods indicated (in thousands):

 

		March 31, 2006			December 31, 2005
		(Unaudited)
Notes payable to banks, due in semi-annual installments, variable interest based on LIBOR, or with interest rates ranging from 4.16% to 6.23% through 2012 to 2020, secured by aircraft		$	660,908		$	666,758
Notes payable to a financing company, due in semi-annual installments, variable interest based on LIBOR, or with interest rates ranging from 3.51% to 7.01% through 2006 to 2021, secured by aircraft		643,656			643,831
Notes payable to banks, due in semi-annual installments plus interest at 6.06% to 7.18% through 2021, secured by aircraft		294,002			297,624
Notes payable to a financing company, due in semi-annual installments plus interest at 5.78% to 6.23% through 2019, secured by aircraft		90,292			93,327
Notes payable to banks, due in monthly installments plus interest of 6.05% to 7.38% through 2020, secured by aircraft		30,876			31,406
Notes payable to banks, due in semi-annual installments, plus interest at 3.72% to 3.86%, net of the benefits of interest rate subsidies through the Brazilian Export financing program, through 2011, secured by aircraft		13,249			13,546
Notes payable to a bank, due in monthly installments interest based on LIBOR through 2012, interest rate at 7.9% secured by building		7,298			7,411
Long-term debt		$	1,740,281		$	1,753,903
Less current maturities		(279,063		)	(331,145		)
Long-term debt, net of current maturities		$	1,461,218		$	1,422,758

 

At March 31, 2006, the three-month and six-month LIBOR rates were 5.0% and 5.14%, respectively.   At December 31, 2005, the three-month and six-month LIBOR rates were 4.54% and 4.70%, respectively.

 

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The aggregate amounts of principal maturities of long-term debt as of March 31, 2006 were as follows (in thousands):

 

2007		279,063
2008		99,884
2009		104,111
2010		108,540
2011		113,199
Thereafter		1,035,484
		$	1,740,281

 

During 2005, we increased an existing $10.0 million line-of-credit facility, with a bank, to $40.0 million. As of March 31, 2006, we borrowed $30.0 million under the facility. The facility expires on January 31, 2007 and bears interest at a rate equal to prime less 0.25%, which was a net rate of 7.5% on March 31, 2006.  Additionally, we entered into another borrowing facility with a financing company and borrowed $60.0 million. The facility expired on March 21, 2006.  Prior to that date, we extended the due date on the line to September 30, 2006.  The facility bears interest on a floating basis which was 7.07% at March 31, 2006.  The borrowings under these facilities were paid off subsequent to March 31, 2006.

 

During the quarter ended March 31, 2006, we refinanced four ASA CRJ200s from short-term financing facilities into long-term financing facilities.

 

As of March 31, 2006, we had $34.9 million in letters of credit and surety bonds outstanding with various banks and surety institutions.

 

Certain of our long-term debt arrangements contain limitations on, among other things, the sale or lease of assets and ratio of long-term debt to tangible net worth.  As of March 31, 2006, we were in compliance with all debt covenants contained in our long-term debt agreements. 

 

Note I – Commitments and Contingencies

 

We lease 262 aircraft, as well as airport facilities, office space, and various other property and equipment under non-cancelable operating leases which are generally on a long-term net rent basis where we pay taxes, maintenance, insurance and certain other operating expenses applicable to the leased property.  We expect that, in the normal course of business, leases that expire will be renewed or replaced by other leases.  The following table summarizes future minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of March  31, 2006 (in thousands):

 

 

On March 31, 2006, we had commitments of approximately $463 million to purchase 17 CRJ900 aircraft and related flight equipment.  We currently anticipate that we will take delivery of these aircraft from April 2006 through April 2007.  We have also obtained options to acquire another 70 CRJ aircraft that can be delivered in either 70 or 90-seat configurations.  We presently anticipate that delivery dates for these aircraft could start in May 2007 and continue through April 2010; however, actual delivery dates remain subject to final determination as agreed upon by us and our code-share partners.

 

In January 2003, the FASB issued Interpretation No. 46, or (FIN 46), Consolidation of Variable Interest Entities, which requires the consolidation of variable interest entities. The majority of the our leased aircraft are owned and leased through trusts whose sole purpose is to purchase, finance and lease these aircraft to us; therefore, they meet the criteria of a variable interest entity. However, since these are single owner trusts in which we do not participate, we believe that we are not at risk for losses and are not considered the primary beneficiary. As a result, based on the current rules, we are not required to consolidate any of these trusts or any other entities in applying FIN 46. We believe that our maximum exposure under these leases is the aggregated amount of the remaining

 

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lease payments.

 

     We have leveraged lease agreements that typically agree to indemnify the equity/owner participant against liabilities that may arise due to changes in benefits from tax ownership of the respective leased aircraft.  The terms of these contracts range up to 18 years.   We did not accrue any liability relating to the indemnification to the equity/owner participant because the probability of this occurring is remote.

 

Note J – Legal Matters

 

We are subject to certain legal actions which we consider routine to our business activities.  As of March 31, 2006, we concluded, after consultation with legal counsel, that the ultimate outcome of such legal matters is not likely to have a material adverse effect on our financial position, liquidity or results of operations.

 

Note K – Subsequent Events

 

On April 17, 2006, we completed a public offering of 4,000,000 shares of common stock at a price of $26.05 per share. We received approximately $99.3 million in proceeds which were used for reduction of two revolving lines of credit, working capital and general corporate purposes.

 

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ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Overview

 

The following discussion and analysis presents factors that had a material effect on the results of operations of SkyWest, Inc. (“we” or “us”) during the quarters ended March 31, 2006 and 2005. Also discussed is our financial position as of the end of March 31, 2006 and 2005. You should read this discussion in conjunction with our consolidated financial statements, including the notes thereto, appearing elsewhere in this report or incorporated herein by reference.  This discussion and analysis contains forward-looking statements. Please refer to the sections of this Report entitled ‘‘Cautionary Statement Concerning Forward-Looking Statements’’ and “ Risk Factors” for discussion of the uncertainties, risks and assumptions associated with these statements.

 

Overview

 

Through our wholly-owned subsidiaries, SkyWest Airlines, Inc. (“SkyWest Airlines”) and Atlantic Southeast Airlines, Inc. (“ASA”), we operate the largest regional airline in the United States.  As of March 31, 2006, SkyWest Airlines and ASA offered scheduled passenger and air freight service with approximately 2,360 total daily departures to 218 destinations in the United States, Canada, Mexico and the Caribbean.  Additionally, we provide ground handling services for approximately ten other airlines throughout our system.  As of March 31, 2006, our consolidated fleet consisted of 229 Bombardier CRJ200 Regional Jets (“CRJ200s”) (66 assigned to United Air Lines, Inc. (“United”) and 163 assigned to Delta Air Lines, Inc. (“Delta”), 92 Bombardier CRJ700 Regional Jets (“CRJ700s”) (52 assigned to United and 40 assigned to Delta), 62 Embraer EMB-120 Brasilia turboprops (“Brasilia turboprops”) (50 assigned to United and 12 assigned to Delta), and 12 Avions de Transport 72-210 turboprops (“ATR-72 turboprops”) (all assigned to Delta).  We believe our success in attracting multiple contractual relationships with major airline partners is attributable to our delivery of high-quality customer service with an all cabin-class fleet at a competitive cost structure.  For the month ended March 31, 2006, approximately 59.0% of our aggregate capacity was operated under the Delta code and approximately 41.0% was operated under the United code.

 

SkyWest Airlines has been a partner with Delta in Salt Lake City and United in Los Angeles since 1987 and 1997, respectively.  In 1998, SkyWest Airlines expanded its relationship with United to provide service in Portland, Seattle/Tacoma, San Francisco and additional Los Angeles markets.  In 2001, SkyWest Airlines expanded its operations to serve as the Delta Connection in Dallas/Fort Worth.  However, effective January 31, 2005, SkyWest Airlines re-deployed all its Delta Connection flights to Salt Lake City as a result of Delta’s decision to “de-hub” its Dallas/Fort Worth operations.  In 2004, SkyWest Airlines expanded its United Express operations to provide service in Chicago.  As of March 31, 2006, SkyWest Airlines operated as a Delta Connection carrier in Salt Lake City, and as a United Express carrier in Los Angeles, San Francisco, Denver, Chicago and the Pacific Northwest, operating more than 1,500 total daily flights.

 

On September 7, 2005, we completed the acquisition of ASA from Delta for $421.3 million in cash.  Additionally, as part of the purchase, we paid $5.3 million of transaction fees and ASA assumed approximately $1.25 billion in long-term debt.  In addition, we returned to Delta $50 million in deposits that Delta had previously paid on future ASA aircraft deliveries.  We believe the combination of SkyWest Airlines and ASA presents our company with new opportunities for growth through our two geographically-focused regional airline platforms – SkyWest Airlines in the Western United States and ASA in the Eastern United States.  We now provide the vast majority of regional airline service for Delta in Atlanta, its most important eastern hub, and Salt Lake City, its most important western hub.  In connection with the ASA acquisition, we have established new, separate, but substantially similar, long-term fixed-fee Delta Connection Agreements with Delta for both SkyWest Airlines and ASA.  We also obtained control of 26 gates in the Hartsfield-Jackson International Airport located in Atlanta, from which we currently provide service to Delta.  Delta has committed to provide to us opportunities to utilize 28 additional regional jets in our fleet by the end of 2007.  Delta has also agreed that, starting in 2008, ASA is guaranteed to maintain its percentage of total Delta Connection flights that it has in 2007, so long as its bid for additional regional flying is competitive with other regional carriers.

 

ASA has been a code-share partner with Delta in Atlanta since 1984.  ASA expanded its operations as a Delta Connection carrier to also include Cincinnati/Northern Kentucky and Salt Lake City in September 2002 and April 2003, respectively.  ASA operates approximately 850 daily flights, all in the Delta Connection system.

 

Historically, multiple contractual relationships have enabled us to reduce reliance on any single major airline code and to enhance and stabilize operating results through a mix of our controlled or “pro-rate” flying and contract flying.  On contract routes, the major

 

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airline partner controls scheduling, ticketing, pricing and seat inventories and we are compensated by the major airline partner at contracted rates based on the completed block hours, flight departures and other operating measures.  On pro-rate flights, we control scheduling, ticketing, pricing and seat inventories and receive a pro-rated portion of passenger fares.  Since August 1, 2003, substantially all of our flights have been contract flights.  For the quarter ended March 31, 2006, essentially all of our Brasilia turboprops flown for Delta were flown under pro-rate arrangements while approximately 92% of our Brasilia turboprops flown in the United system were flown under contractual arrangements, with the remaining eight percent flown under pro-rate arrangements.

 

In September 2005, Delta filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code. Prior to the date of Delta’s bankruptcy filing, each of SkyWest Airlines and ASA entered into an amended Delta Connection Agreement which provides for a
15-year term, subject to certain termination and extension rights.  Delta received all necessary approvals from the U.S. Bankruptcy Court and the Delta Connection Agreements were assumed by Delta on October 6, 2005.  Under the terms of its Delta Connection Agreement, SkyWest Airlines is compensated primarily on a fee-per-completed-block hour and departure basis, is reimbursed for fuel and other direct costs, and is paid a margin based on completed block hours.  Under its Delta Connection Agreement, ASA is compensated primarily on a fee-per-completed-block-hour basis, is directly reimbursed for fuel and other costs, and is paid a margin based on performance incentives. Notwithstanding the assumption by Delta of the Delta Connection Agreements, Delta’s bankruptcy filing could still lead to many other unforeseen expenses, risks and uncertainties for SkyWest Airlines, ASA or both.

 

Although Delta has reported that it intends to reorganize and emerge from its ongoing Chapter 11 bankruptcy proceeding, it could convert its reorganization proceeding to a liquidation proceeding under the U.S. Bankruptcy Code or liquidate some or all of its assets through one or more transactions with third parties.  Such events could jeopardize our Delta Connection operations, leave us unable to efficiently utilize the additional aircraft which we are currently obligated to purchase, or result in other outcomes which could have a material adverse effect on our operating results or financial condition.

 

Although a plan of reorganization has been confirmed in United’s bankruptcy proceedings, which became effective on February 1, 2006 (subject to pending appeals), there is no assurance that United’s plan will ultimately succeed.  Among other uncertainties, United’s order of confirmation is subject to pending appeals.  There is no assurance that United will be able to operate successfully under the terms of its plan.  In the event United is not able to perform successfully under the terms of its plan, our United Express operations could be jeopardized, which could have a material adverse effect on our operating results or financial condition.

 

On February 4, 2005, we announced that SkyWest had been selected by United to operate 20 new CRJ700s in its United Express operations, and that SkyWest had placed a firm order for these CRJ700s with Bombardier.  Deliveries of these aircraft began in the third quarter of 2005 and these deliveries were completed in March 2006.  Our total firm aircraft orders and commitments, as of March 31, 2006, consisted of orders for 17 Bombardier CRJ900 Regional Jets (“CRJ900s”) and commitments to lease six CRJ200’s from Delta.  Total expenditures for these aircraft and related flight equipment, including amounts for contractual price escalations are estimated to be approximately $463 million through April 2007.  Additionally, our agreement with Bombardier includes options for another 70 aircraft that can be delivered in either 70 or 90-seat configurations.  We presently anticipate that delivery dates for these aircraft could start in January 2007 and continue through April 2010; however, actual delivery dates remain subject to final determination as agreed upon by us and our code-share partners.

 

Cautionary Statement Concerning Forward-Looking Statements

 

Certain of the statements contained in this Quarterly Report on Form 10-Q should be considered “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements may be identified by words such as “may,” “will,” “expect,” “intend,” “anticipate,” “believe,” “estimate,” “plan,” “project,” “could,” “should,” “hope,” “likely,” and “continue” and similar terms used in connection with statements regarding our outlook, the revenue environment, our contract relationships, and our expected financial performance.  These statements include, but are not limited to, statements about the benefits of our acquisition of ASA, including our future financial and operating results, our plans for SkyWest Airlines and ASA, our objectives, expectations and intentions and other statements that are not historical facts.  You should also keep in mind that all forward-looking statements are based on our existing beliefs about present and future events outside of our control and on assumptions that may prove to be incorrect.  If one or more risks identified in this report, or any applicable filings materializes, or any other underlying assumptions prove incorrect, our actual results may vary materially from those anticipated, estimated, projected, or intended.  These risks and uncertainties include, but are not limited to, those described below in Item 1A., Risk Factors, and the following:

 

•	our ability to achieve anticipated potential benefits with respect to our acquisition of ASA;
•	our ability to obtain and maintain financing necessary for operations and other purposes;

 

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•	our ability to maintain adequate liquidity;
•	the impact of high fuel prices on the airline industry;
•	the impact of global instability, including the continued impact of the United States military presence in foreign countries, the September 11, 2001 terrorist attacks and the potential impact of future hostilities, terrorist attacks or other global events;
•	our ability to attract and retain code-share partners;
•	changes in our code-share relationships;
•	the cyclical nature of the airline industry;
•	competitive practices in the airline industry, including significant fare-restructuring activities, capacity reductions and bankruptcy and other airline restructurings by major and regional carriers, including Delta and United;
•	global and national economic conditions;
•	labor costs;
•	security-related and insurance costs;
•	weather conditions;
•	government legislation and regulation;
•	unfavorable resolution of negotiations with municipalities for the leasing of facilities;
•	relations with ASA’s unionized employees and the impact and outcome of labor negotiations;
•	unionization efforts among SkyWest Airlines’ employees; and
•	other risks and uncertainties listed from time to time in our reports filed with the SEC.

 

There may be other factors not identified above of which we are not currently aware that may affect matters discussed in the forward-looking statements, and may also cause actual results to differ materially from those discussed.  We assume no obligation to publicly update any forward-looking statement to reflect actual results, changes in assumptions or changes in other factors affecting these statements other than as required by law.

 

Critical Accounting Policies

 

Our significant accounting policies are summarized in Note 1 to our consolidated financial statements for the year ended December 31, 2005, which are presented in our Annual Report on Form 10-K filed with the SEC on March 14, 2006.  Critical accounting policies are those policies that are most important to the preparation of our consolidated financial statements and require management’s subjective and complex judgments due to the need to make estimates about the effect of matters that are inherently uncertain. Our critical accounting policies relate to revenue recognition, aircraft maintenance, aircraft leases and impairment of long-lived assets and intangibles as discussed below. The application of these accounting policies involves the exercise of judgment and the use of assumptions as to future uncertainties and, as a result, actual results will differ, and could differ materially from such estimates.

 

Adoption of SFAS 123(R)

 

Prior to January 1, 2006, we applied Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its stock-based compensation plans.  Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, requires pro forma information regarding net income and net income per share as if the Company had accounted for its stock options under the fair value method.  We did not record any stock-based compensation expense related to stock options for the year ended December 31, 2005.

 

Effective January 1, 2006 the Company adopted the fair value recognition provisions of SFAS No. 123(R), Share-Based Payment, using the modified-prospective-transition method.  Under that modified-prospective-transition method, compensation cost recognized during the three months ended March 31, 2006 includes compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123(R).  Results for prior periods have not been restated.

 

The fair value of stock options has been estimated as of the grant date using the Black-Scholes option pricing model.  During the quarter ended March 31, 2006 we did not grant any stock options.  The following assumptions were used for grants for the years  ended December 31, 2005 and 2004: a risk-free interest rate of 3.87% for 2005 and 2.75% for 2004, a volatility factor of the expected common stock price of .391 for 2005 and .422 for 2004, a weighted average expected life of six years for the stock options granted in February 2005 and a weighted average expected life of four years for all previously granted options presented and an expected annual dividend rate of 0.70% for 2005 and 0.63% for 2004. We used historical data to estimate pre-vesting option forfeitures.  As required by SFAS 123(R), we recorded share-based compensation expense only for those options that are expected to vest.  Forfeiture rates for the years 2005 and 2004 were estimated to be 6.70% and 6.60%, respectively.  The estimated fair value of the stock options is amortized over the vesting period of the respective stock option grants.

 

We had $9.4 million of total unrecognized compensation cost related to non-vested stock options.  Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.  We expect to recognize this cost over a weighted average period of 1.7 years. 

 

Revenue Recognition

 

Passenger and ground handling revenues are recognized when service is provided. Under our contract and pro-rate flying agreements with our code-share partners, revenue is considered earned when the flight is completed. In the event that our contractual rates have not been finalized at quarterly or annual financial statement dates, we record revenues based on a prior period’s approved rates, adjusted to reflect management’s current estimate of the results of the then-current contract negotiations. Our agreements with our code-share partners contain certain provisions pursuant to which the parties could terminate the respective agreements, subject to certain rights of the other party, if certain performance criteria are not maintained. Our revenues could be impacted by a number of factors, including changes to the code-share agreements, contract modifications resulting from contract renegotiations and our ability to earn incentive payments contemplated under applicable agreements.

 

Maintenance

 

       We use the direct-expense method of accounting for our regional jet aircraft engine overhaul costs. Under this method, the maintenance liability is not recorded until the maintenance services are performed, thus substantially reducing significant estimates and judgments inherent under the accrual method. We use the “deferral method” of accounting for our Brasilia turboprop engine overhauls, which provides for engine overhaul costs to be capitalized and depreciated over the estimated useful life of the engine. For leased aircraft, we are subject to lease return provisions that require a minimum portion of the “life” of an overhaul be remaining on the engine at the lease return date. With respect to engine overhauls related to leased Brasilia turboprops to be returned, we adjust the estimated useful lives of the final engine overhauls based on the respective lease return dates. With respect to SkyWest Airlines, a third-party vendor provides our long-term engine services covering the scheduled and unscheduled repairs for engines on our CRJ700s. Under the terms of the

 

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agreement, we pay a set dollar amount per engine hour flown on a monthly basis and the third-party vendor assumes the obligation to repair the engines at no additional cost to us, subject to certain specified exclusions.

 

Aircraft Leases

 

The majority of SkyWest Airlines’ aircraft are leased from third parties, while ASA’s aircraft are primarily debt-financed on a long-term basis. In order to determine the proper classification of our leased aircraft as either operating leases or capital leases, we must make certain estimates at the inception of the lease relating to the economic useful life and the fair value of an asset as well as select an appropriate discount rate to be used in discounting future lease payments. These estimates are utilized by management in making computations as required by existing accounting standards that determine whether the lease is classified as an operating lease or a capital lease. All of our aircraft leases have been classified as operating leases, which results in rental payments being charged to expense over the terms of the related leases. Additionally, operating leases are not reflected in our condensed consolidated balance sheet and accordingly, neither a lease asset nor an obligation for future lease payments is reflected in our condensed consolidated balance sheet.

 

Impairment of Long-Lived and Intangible Assets

 

As of March 31, 2006, we had approximately $2.5 billion of property and equipment and related assets.  Additionally, as of March 31, 2006, we had approximately $32.4 million in net intangible assets.  In accounting for these long-lived and intangible assets, we make estimates about the expected useful lives of the assets, the expected residual values of certain of these assets, and the potential for impairment based on the fair value of the assets and the cash flows they generate.  We recorded an intangible of approximately $33.0 million relating to the acquisition of ASA.  The intangible is being amortized over fifteen years under the straight-line method.  As of March 31, 2006, we had recorded $572,117 in amortization expense.  Factors indicating potential impairment include, but are not limited to, significant decreases in the market value of the long-lived assets, a significant change in the condition of the long-lived assets and operating cash flow losses associated with the use of the long-lived assets.  On a periodic basis, we evaluate whether the book value of our aircraft is impaired in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”  Based on the results of the evaluations, our management concluded no impairment was necessary as of March 31, 2006.  However, there is inherent risk in estimating the future cash flows used in the impairment test.  If cash flows do not materialize as estimated, there is a risk the impairment charges recognized to date may be inaccurate, or further impairment charges may be necessary in the future.

 

Results of Operations

 

Quarter Ended March 31, 2006 and 2005

 

Operating Statistics.   The following table sets forth the major operational statistics of our company and the percentage-of-change for the quarters identified below.

 

 

Our total available seat miles, or ASMs generated during the quarter ended March 31, 2006 increased 110.8% from the quarter ended March 31, 2005.  The increase in ASMs was primarily a result of increasing the size of our aircraft fleet, including our acquisition of ASA, from 219 aircraft as of March 31, 2005, to 395 aircraft as of March 31, 2006.  On the date we acquired ASA,

 

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ASA’s fleet consisted of 149 aircraft (35 CRJ700s, 102 CRJ200s and 12 ATRs).  In addition to the aircraft acquired in connection with the acquisition of ASA, we took delivery of 15 CRJ 700s during the quarter ended March 31, 2006.

 

Net Income.  Net income increased to $34.6 million, or $0.57 per diluted share, for the quarter ended March 31, 2006, compared to $18.8 million, or $0.32 per diluted share, for the quarter ended March 31, 2005.  Factors relating to the change in net income are discussed below.

 

Operating Revenues.  Operating revenues increased 118.3% for the quarter ended March 31, 2006, compared to the quarter ended March 31, 2005.  The increase in total operating revenues was primarily due to the acquisition of ASA.  Airline operating and interest expenses, excluding fuel charges, per ASM decreased 4.9% to 9.8¢ for the quarter ended March 31, 2006, from 10.3¢ for the quarter ended March 31, 2005.  The primary reason for the decrease was the increased capacity of our regional jet aircraft and the increase in stage lengths flown by our regional jet aircraft.

 

Passenger Revenues.  Passenger revenues, which represented 98.9% of consolidated operating revenues for the quarter ended March 31, 2006, increased 118.9% to $734.4 million for the quarter ended March 31, 2006, from $335.6 million, or 98.6% of consolidated operating revenues, for the quarter ended March 31, 2005.  Our passenger revenues, excluding fuel reimbursements from major partners, increased 100.6% for the quarter ended March 31, 2006.  The increase in passenger revenues excluding fuel was primarily due to a 110.8% increase in ASMs, principally as a result of our increase in operating aircraft to 395 aircraft as of March 31, 2006, from 219 aircraft as of March 31, 2005.  Revenue per ASM increased 3.3% to 15.8¢, from 15.3¢ for the quarter ended March 31, 2005, primarily due to an increase in fuel reimbursements from our major partners.  Passenger revenues include an amount designed to reimburse us for aircraft ownership costs.  The amount deemed to be rental income for the quarter ended March 31, 2006 was $117.3 million.

 

Passenger Load Factor.  Passenger load factor increased to 77.6% for the quarter ended March 31, 2006, from 73.2% for the quarter ended March 31, 2005.  The increase in load factor was due primarily to the further development of our relationships with United and Delta, whereby we supplement mainline service in previously established and developed markets.  Additionally, we are experiencing higher passenger acceptance of our regional jet aircraft.

 

Ground Handling and Other Revenue.  Total ground handling revenue for the quarter ended March 31, 2006 increased approximately 78.0% from the same period of 2005.  The increase was primarily related to contracts with United and Delta, whereby we perform the ground handling for several other regional airlines.

 

Total Airline Expenses Excluding Fuel.  Total airline expenses for the quarter ended March 31, 2006, excluding fuel charges (which are substantially reimbursable by our major partners), increased approximately 100.1% from the same period of 2005.  The increase was primarily a result of a 110.8% increase in ASMs (which resulted principally from the acquisition of ASA).  Total operating expenses for the quarter ended March 31, 2006 increased at a lower rate than ASM growth, primarily due to the increased operating efficiencies obtained from increased stage lengths flown by the regional jets.

 

Operating and Interest Expenses. Operating and interest expenses increased 120.3% to $688.5 million for the quarter ended March 31, 2006, compared to $312.5 million for the quarter ended March 31, 2005.  The increase in total operating and interest expenses was due principally to the acquisition of ASA.  As a percentage of consolidated operating revenues, total operating and interest expenses increased to 92.7% for the quarter ended March 31, 2006, from 91.8% for the quarter ended March 31, 2005.  The increase in operating and interest expenses as a percentage of consolidated operating revenues was primarily due to significant increases in fuel costs quarter-over-quarter.

 

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The following table sets forth information regarding our operating expense components for the quarters ended March 31, 2006 and 2005.  Operating expenses are expressed as a percentage of operating revenues. Individual expense components are also expressed as cents per ASM.

 

		Quarter ended March 31,
		2006							2005
		Amount			Percentage of Revenue		Cents per ASM		Amount			Percentage of Revenue		Cents Per ASM
		(in thousands)							(in thousands)
Salaries, wages and employee benefits		$	165,325		22.3	%	3.5	¢	$	83,414		24.5	%	3.6	¢
Aircraft costs		113,837			15.3		2.4		64,579			19.0		2.9
Maintenance		55,178			7.4		1.2		21,742			6.4		1.0
Fuel		224,663			30.2		4.8		81,418			23.9		3.7
Other airline expenses		100,989			13.6		2.1		54,692			16.1		2.5
Interest		28,543			3.8		0.6		6,646			2.0		0.3
Total airline expenses		$	688,535				14.6	¢	$	312,491				14.0	¢

 

The cost per ASM for salaries, wages and employee benefits decreased to 3.5¢ for the quarter ended March 31, 2006, compared to 3.6¢ for the quarter ended March 31, 2005.  The average number of full-time equivalent employees increased 82.6% to 13,080 for the quarter ended March 31, 2006 from 7,162 for the quarter ended March 31, 2005.  The increase in number of employees was due, in large part, to the acquisition of ASA and addition of personnel required for the new regional jet flying and ground handling operations within our United Express operations.

 

The cost per ASM for aircraft costs, including aircraft rent and depreciation, decreased to 2.4¢ for the quarter ended March 31, 2006, from 2.9¢ for the quarter ended March 31, 2005.  The decrease in cost per ASM was primarily due to the addition of ASA’s regional jet fleet and the addition of 45 CRJ700s, which have a lower operating cost per ASM than our existing CRJ200 and turboprop fleets.

 

The cost per ASM for maintenance expense increased to 1.2¢ for the quarter ended March 31, 2006, compared to 1.0¢ for the quarter ended March 31, 2005.  The increase was primarily relates to the timing of certain maintenance events during the quarter ended March 31, 2006.  Under our United Express Agreement, specific amounts are included in the rates and charges for mature maintenance on regional jet engines that we record as revenue.  However, consistent with the change to a direct expense maintenance policy, we record maintenance expense on our CRJ200 engines as it is incurred.  As a result, during the quarter ended March 31, 2006, we collected and recorded as revenue $6.5 million (pretax) under the United Express Agreement, with no material corresponding expense relative to CRJ200 engine maintenance overhauls.  Because the “Maintenance” line in the table set forth above does not include salaries, wages and employee benefits associated with our maintenance operations (those costs are stated separately in the table), the maintenance expense line in the above table differs from the maintenance line in our Condensed Consolidated Statements of Income.

 

The cost per ASM for fuel increased 29.7% to 4.8¢ for the quarter ended March 31, 2006, from 3.7¢ for the quarter ended March 31, 2005.  This increase was primarily due to the average price of fuel increasing to $2.09 per gallon during the quarter ended March 31, 2006, from $1.61 per gallon for the quarter ended March 31, 2005.

 

The cost per ASM for other expenses, primarily consisting of landing fees, station rentals, computer reservation system fees and hull and liability insurance, decreased 16.0% to 2.1¢ for the quarter ended March 31, 2006, from 2.5¢ for the quarter ended March 31, 2005. The decrease was primarily related to the increase in stage lengths flown by our regional jets.

 

Interest expense increased to approximately $28.5 million during the quarter ended March 31, 2006, from approximately $6.6 million during the quarter ended March 31, 2005.  The increase in interest expense was primarily due to the acquisition of ASA’s aircraft which are primarily financed with long-term debt.

 

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Liquidity and Capital Resources

 

We had working capital of $192.4 million and a current ratio of 1.3:1 at March 31, 2006, compared to working capital of $77.7 million and a current ratio of 1.1:1 at December 31, 2005. The increase was principally caused by the refinancing of certain aircraft to longer term facilities.  The principal sources of cash during the quarter ended March 31, 2006 were $44.8 million provided by operating activities, $16.8 million of proceeds from the sale of marketable securities, $7.6 million from returns on aircraft deposits, $7.1 million in proceeds from issuance of long-term debt, and $13.5 million from the sale of common stock in connection with the exercise of stock options under our stock option and employee stock purchase plans, and $5.7 million of proceeds from the sale of owned aircraft and $0.4 million in tax benefit from exercise options to purchase shares of common stock.  We invested $33.8 million in purchases of marketable securities, $17.1 million in flight equipment, $11.6 million in other assets, $3.7 million in buildings and ground equipment and $0.4 million in deposits for aircraft.  We made principal payments on long-term debt of $20.7 million, and paid $1.8 million in cash dividends.  These factors resulted in a $6.8 million increase in cash and cash equivalents during the quarter ended March 31, 2006.

 

We believe that in the absence of unusual circumstances, the working capital available to us will be sufficient to meet our present financial requirements, including expansion, capital expenditures, lease payments and debt service obligations for at least the next 12 months.

 

Our position in marketable securities, consisting primarily of bonds, bond funds and commercial paper, increased to $175.8 million at March 31, 2006, compared to $159.0 million at December 31, 2005.  The increase in marketable securities was due primarily to the $44.8 million in cash provided for through operating activities for the quarter.

 

At March 31, 2006, our total capital mix was 39.7% equity and 60.3% debt, compared to 39.1% equity and 60.9% debt at December 31, 2005.

 

During 2005, SkyWest Airlines increased an existing $10.0 million line-of-credit facility, with a bank, to $40.0 million. As of March 31, 2006, SkyWest Airlines had borrowed $30.0 million under the facility. The facility expires on January 31, 2007 and bears interest at a rate equal to prime less 0.25%, which was a net rate of 7.5% on March 31, 2006.  Additionally, SkyWest Airlines entered into another borrowing facility with a financing company and borrowed $60.0 million with interest payable on a floating basis, which interest rate was 7.07% at March 31, 2006.  Subsequent to March 31, 2006, we repaid in full all amounts borrowed under both facilities.

 

As of March 31, 2006, we had $34.9 million in letters of credit and surety bonds outstanding with various banks and surety institutions.

 

On March 31, 2006, we classified $22.1 million as restricted cash, related to our workers compensation policies and the purchase of ASA. On December 31, 2005, we classified $24.8 million as restricted cash as required by our workers compensation policy.

 

On April 17, 2006, we completed a public offering of 4,000,000 shares of common stock at a price of $26.05 per share. We received approximately $99.3 million in proceeds which were used for reduction of two revolving lines of credit, working capital and general corporate purposes.

 

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Significant Commitments and Obligations

 

General

 

The following table summarizes our commitments and obligations stated in calendar years except as noted for each of the next five years and thereafter (in thousands):

 

		Total			Apr-Dec 2006			2007			2008			2009			2010			2011			Thereafter
Firm aircraft Commitments		$	463,000		$	243,000		$	220,000		$	—		$	—		$	—		$	—		$	—
Operating lease payments for aircraft and facility obligations		3,627,467			256,661			302,277			278,434			293,723			287,274			284,170			1,924,928
Principal maturities on long-term debt		1,740,281			258,977			99,063			103,175			107,588			112,193			114,454			944,831
Lines of Credit		90,000			60,000			30,000			—			—			—			—			—
Total commitments and obligations		$	5,920,748		$	818,638		$	651,340		$	381,609		$	401,311		$	399,467		$	398,624		$	2,869,759

 

Purchase Commitments and Options

 

On February 4, 2005, we announced that SkyWest Airlines had been selected by United to operate 20 new CRJ700s in its United Express operations, and that SkyWest Airlines had placed a firm order for these CRJ700s with Bombardier.  Deliveries of these aircraft began in the third quarter of 2005 and these deliveries were completed in March 2006.  Our total firm aircraft orders and commitments as of March 31, 2006, consisted of orders for 17 CRJ900s and commitments to lease six CRJ200’s from Delta.  Total expenditures for these aircraft and related flight equipment, including amounts for contractual price escalations are estimated to be approximately $463 million.  Additionally, our agreement with Bombardier includes options for another 70 aircraft that can be delivered in either 70 or 90-seat configurations.  We presently anticipate that delivery dates for these aircraft could start in May 2007 and continue through April 2010; however, actual delivery dates remain subject to final determination as agreed upon by us and our code-share partners.

 

SkyWest Airlines has not historically funded a substantial portion of its aircraft acquisitions with working capital.  Rather, it has generally funded its aircraft acquisitions through a combination of operating leases and debt financing.  At the time of each aircraft acquisition, we evaluate the financing alternatives available, and selected one or more of these methods to fund the acquisition.  In the event that alternative financing can not be arranged at the time of delivery, Bombardier has financed aircraft acquisitions until more permanent arrangements can be made.  Subsequent to this initial acquisition of an aircraft, we may also refinance the aircraft or convert one form of financing to another (e.g., replacing debt financing with leveraged lease financing).

 

At present, we intend to satisfy our 2006 firm aircraft purchase commitment, as well as our acquisition of any additional aircraft, through a combination of operating leases and debt financing, consistent with our historical practices.  Based on current market conditions and discussions with prospective leasing organizations and financial institutions, we currently believe that we will be able to obtain financing for the committed acquisitions, as well as additional aircraft, without materially reducing the amount of working capital available for our operating activities.

 

Aircraft Lease and Facility Obligations

 

We also have significant long-term lease obligations primarily relating to our aircraft fleet.  At March 31, 2006, we had 262 aircraft under lease with remaining terms ranging from one to 18 years.  Future minimum lease payments due under all long-term operating leases were approximately $3.6 billion at March 31, 2006.  Assuming a 7.39% discount rate, which is the rate used to approximate the implicit rates within the applicable aircraft leases, the present value of these lease obligations would have been equal to approximately $2.3 billion at March 31, 2006.

 

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As part of our leveraged lease agreements, we typically agree to indemnify the equity/owner participant against liabilities that may arise due to changes in benefits from tax ownership of the respective leased aircraft.

 

Long-term Debt Obligations

 

Our total long-term debt at March 31, 2006 was $1,740.3 million, of which $1,733.0 million related to the acquisition of Brasilia turboprop, CRJ200 and CRJ700 aircraft and $7.3 million related to our corporate office building.   The average effective rate on the debt related to the Brasilia turboprop and CRJ200 aircraft was approximately 5.7% at March 31, 2006.  Approximately, $183.7 million of our current portion of long-term debt is expected to be refinanced into permanent long-term financing within the next year.

 

Seasonality

 

As is common in the airline industry, our pro-rate operations are favorably affected by increased travel, historically occurring in the summer months, and are unfavorably affected by decreased business travel during the months from November through January and by inclement weather which occasionally results in cancelled flights, principally during the winter months.

 

During the first quarter of 2005, we experienced significant weather-related cancellations, primarily in January, of 1,325 flights which is approximately 3.1% of total scheduled departures.  Based on historical averages for weather-related cancellations of one-half of one percent, it is estimated that we experienced approximately 1,100 more cancellations than normal during January 2005.  The cancellations contributed to an increase in certain cost components, while we were unable to record the revenue for the cancelled flights.

 

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Aircraft Fuel

 

In the past, we have not experienced difficulties with fuel availability and we currently expect to be able to obtain fuel at prevailing prices in quantities sufficient to meet our future needs.  Pursuant to our contract flying arrangements, United will bear the economic risk of fuel price fluctuations on our United Express flights.  On our Delta Connection regional jet flights, Delta will bear the economic risk of fuel price fluctuations.  On the majority of our Delta Connection routes flown using Brasilia turboprops, we will bear the economic risk of fuel fluctuations.  At present, we believe that our results from operations will not be materially and adversely affected by fuel price volatility.

 

Interest Rates

 

Our earnings are affected by changes in interest rates due to the amounts of variable rate long-term debt and the amount of cash and securities held.  The interest rates applicable to variable rate notes may rise and increase the amount of interest expense.  We would also receive higher amounts of interest income on cash and securities held at the time; however, the market value of our available-for-sale securities would likely decline.  At March 31, 2006, we had variable rate notes representing 68.4% of our total long-term debt compared to 53.0% of our long-term debt at March 31, 2005.  For illustrative purposes only, we have estimated the impact of market risk using a hypothetical increase in interest rates of one percentage point for both variable rate long-term debt and cash and securities.  Based on this hypothetical assumption, we would have incurred an additional $3,200,000 in interest expense and received $850,000 in additional interest income for the quarter ended March 31, 2006.

 

We currently intend to finance the acquisition of aircraft through the manufacturer, third-party leases or long-term borrowings. Changes in interest rates may impact the actual cost to us to acquire these aircraft. To the extent we place these aircraft in service under our code-share agreements with Delta and United, our code-share agreements currently provide that reimbursement rates will be adjusted higher or lower to reflect any changes in our aircraft rental rates.

 

We have an interest rate swap agreement to manage our exposure on the debt instrument related to our headquarters. Our policies do not permit management to enter into derivative instruments for any purpose other than cash flow hedging purposes. Accordingly, we do not speculate using derivative instruments. We assess interest rate cash flow risk by identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating hedging opportunities.  The fair values of our derivative instruments are recognized as other current liabilities in the accompanying balance sheet.  In accordance with

 

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provisions of SFAS No. 133, we recorded a $197,000 and $473,000 liability at March 31, 2006 and 2005 respectively, in the accompanying consolidated balance sheets representing the fair value of the outstanding interest rate swap agreement.  We decreased interest expense by $147,000 and $218,000 during the years ended March 31, 2006 and 2005, respectively, relating to adjustments to the fair value and of the derivatives.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of its disclosure controls and procedures, as such term is defined under Rule 13a-14(c) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of March 31, 2006.  Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to our company required to be included in our reports filed or submitted under the Exchange Act.  There have been no significant changes (including corrective actions with regard to material weaknesses) in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referenced above.

 

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